If sales increase from $80,000 per year to $120,000 per year, and if the operating leverage is 5, then net income should increase by?

Question

Quizplus · Accepted Answer

First, we need to calculate the percentage change in sales:

(120,000-80,000)/80,000 = 0.5 or 50% increase in sales.

Using the operating leverage formula:

Operating leverage = contribution margin/net income

We can rearrange it to solve for net income:

Net income = contribution margin/operating leverage

Assuming no change in variable costs, we can use the contribution margin ratio to find the new contribution margin:

Contribution margin ratio = (sales - variable costs) / sales

Assuming a contribution margin ratio of 40%, the contribution margin for the two sales levels would be:

80,000 x 0.4 = $32,000 
120,000 x 0.4 = $48,000

Plugging these values into the formula:

Net income = contribution margin/operating leverage 
Net income for the initial sales level: 
32,000/5 = $6,400

Net income for the new sales level: 
48,000/5 = $9,600

To find the percentage change in net income:

(9,600-6,400)/6,400 = 0.5 or 50% increase in net income

Therefore, the correct answer is B) 250%.

If Sales Increase from $80,000 Per Year to $120,000 Per